CDO Probe Heats Up

In recent weeks, Wall Street banks have come under fire from regulators over sales of collateralized debt obligations and other toxic mortgage-related investments. Investors, who suffered huge financial losses in the deals, may be surprised to learn that federal regulators are now in preliminary discussions with several major Wall Street firms aimed at resolving their investigations into sales of the risky securities.

As reported Dec. 2 by the Wall Street Journal, the talks are in the early, informal stage and could fall apart at any time.

A similar legal battle over CDOs unfolded earlier this summer between the Securities and Exchange Commission (SEC) and Goldman Sachs. In the end, Goldman agreed to pay $550 million to settle civil charges that it misled investors by not disclosing information about a manufactured CDO and the hedge-fund client betting for it to fail.

Following the Goldman Sachs debacle, the SEC stepped up its scrutiny of CDOs. In particular, regulators began focusing on possible conflicts of interest and how the assets in the CDOs were selected and valued.

According to the Wall Street Journal story, among the CDOs being scrutinized are some invested in by Magnetar Capital, an Illinois hedge-fund firm. One of these is a $1.1 billion deal sold by J.P. Morgan in early 2007. Other CDOs being looked at include a $1 billion deal by Citigroup in 2007 called Class V Funding III.

Regulators also are looking into the suitability of CDOs for investors and whether the products are appropriate investment vehicles for individuals who are not financially savvy.